(b) Government Grants and Contracts 



The Smithsonian receives funding or reimbursement from governmental agencies for 

 various activities which are subject to audit. Audits of these activities have been 

 completed through fiscal year 1997, however, fiscal year 1997 has not been closed with 

 the cognizant federal audit agency. Management believes that any adjustments which 

 may result from this audit and the audit for fiscal year 1998 will not have a materially 

 adverse effect on the Smithsonian's financial statements. 



(c) Litigation 



The Smithsonian is a party to various litigation ansing out of the normal conduct of 

 its operations. In the opinion of the Smithsonian's General Counsel, the ultimate 

 resolution of these matters will not have a materially adverse effect on the Smith- 

 sonian's financial statements. 



(13) Employee Benefit Plans 



The federal employees of the Smithsonian are covered by either the Civil Service Retire- 

 ment System (CSRS) or the Federal Employee Retirement System (FERS). The terms of 

 these plans are defined in federal regulations. Under both systems, the Smithsonian 

 withholds from each federal employee's salary the required salary percentage. The 

 Smithsonian also contributes specified percentages. The Smithsonian's expense for 

 these plans for fiscal year 1998 was 515,959,000. 



The Smithsonian has a separate defined contribution retirement plan for trust fund 

 employees, in which substantially all such employees are eligible to participate. Under 

 the plan, the Smithsonian contributes stipulated percentages of salary which are used 

 to purchase individual annuities, the rights to which are immediately vested with the 

 employees. Emplovees can make voluntary contributions, subject to certain limita- 

 tions. The Smithsonian's cost of the plan for fiscal year 1998 was 59,365,000. 



In addition to the Smithsonian's retirement plans, the Smithsonian makes available 

 certain health care and life insurance benefits to active and retired trust fund employ- 

 ees. The plan is contributory for retirees and requires payment of premiums and de- 

 ductibles. Retiree contributions for premiums are established by an insurance earner 

 based on the average per capita cost of benefit coverage for all participants, active and 

 retired, in the Smithsonian's plan. 



The inclusion of retirees in the calculation of average per capita cost results in a 

 higher average per capita cost than would result if only active employees were covered 

 by the plan. Therefore, the Smithsonian has a postretirement benefit obligation total- 

 ing 56,097,000 at September 30, 1998, for the portion of the expected future cost of the 

 retiree benefits that is not recovered through retiree contnbutions. The Smithsonian's 

 policy is to fund the cost of these benefits on the pay-as-you-go-basis. 



(14) Income Taxes 



The Smithsonian is recognized as exempt from income taxation under the provisions of 

 Section 501(c)(3) of the Internal Revenue Code (the Code). Organizations described in 

 that section are taxable only on their unrelated business income. Periodical advertising 

 sales is the main source of unrelated business income. An IRS determination letter has 

 been received supporting the Smithsonian's taxexempt status. No provision for income 

 taxes was required for fiscal year 1998. 



It is the opinion of the Smithsonian's management that the Smithsonian is also 

 exempt horn taxation as an instrumentality of the United States as defined in Section 

 501(c)(1) of the Code. Organizations described in that section are exempt from all 

 income taxation. The Smithsonian has not yet formally sought such dual status. 



(15) Restructuring of Smithsonian Press / Smithsonian Productions Divisions 



During fiscal year 1998, the Board voted to discontinue operations of three divisions of 

 the Smithsonian Press/Smithsonian Productions auxiliary activity, including Smith- 

 sonian Books, Smithsonian Collection of Recordings, and Smithsonian Videos, effective 

 April 1, 1998. Costs associated with the closure, include write-offs of inventory and 

 accounts receivable, accruals for contractual product and fulfillment contract guaran- 

 tees, guaranteed royalties and commissions, potential merchandise returns, litigation 

 claims and severance costs. In fiscal year 1998, the total loss from operations and 

 closure of the three divisions was $4,791,000, the net effect of which is reported within 

 auxiliary activities in the statement of financial activity. 



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